More seriously, in this interesting paper and in this post, Murphy admits that Sraffa demonstrated that outside of equilibrium there is no single Wicksellian natural rate of interest, and that Hayek never really addressed this problem for his trade cycle theory.

On the face of it, these admissions have devastating consequences for virtually all modern formulations of the Austrian business cycle theory (ABCT) using the unique natural rate, as admitted by Murphy himself:

“In his brief remarks, Hayek certainly did not fully reconcile his analysis of the trade cycle with the possibility of multiple own-rates of interest. Moreover, Hayek never did so later in his career. His Pure Theory of Capital (1975 [1941]) explicitly avoided monetary complications, and he never returned to the matter. Unfortunately, Hayek’s successors have made no progress on this issue, and in fact, have muddled the discussion. As I will show in the case of Ludwig Lachmann—the most prolific Austrian writer on the Sraffa-Hayek dispute over own-rates of interest—modern Austrians not only have failed to resolve the problem raised by Sraffa, but in fact no longer even recognize it.

Austrian expositions of their trade cycle theory never incorporated the points raised during the Sraffa-Hayek debate. Despite several editions, Mises’ magnum opus (1998 [1949]) continued to talk of “the” originary rate of interest, corresponding to the uniform premium placed on present versus future goods. The other definitive Austrian treatise, Murray Rothbard’s (2004 [1962]) Man, Economy, and State, also treats the possibility of different commodity rates of interest as a disequilibrium phenomenon that would be eliminated through entrepreneurship. To my knowledge, the only Austrian to specifically elaborate on Hayekian cycle theory vis-à-vis Sraffa’s challenge is Ludwig Lachmann.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 11–12).

“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does. The rate of return (in intertemporal equilibrium) on all commodities must indeed be equal once we define a numéraire, but there is no reason to suppose that those rates will be equal regardless of the numéraire. As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to “the” real rate of interest.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).

If Mosler debates Murphy, he should press him repeatedly on both points.

First, Mosler should point out that Murphy agrees with Keynes on the nature of the interest rate. So does Murphy admit that Keynesians are right in their interest rate theory?

The instant Murphy attempts to explain recessions in terms of the Austrian business cycle theory (ABCT), Mosler should demand to know what version of the ABCT Murphy is using.

Some other points:

(1) Murphy and other Austrians do not properly understand the price system in real world capitalism. They do not understand and (often) do not even acknowledge the reality of extensive fixprice markets and price administration. Many businesses do not adjust prices in reaction to demand changes, but supply: that is, they adjust output and employment. That is a strong confirmation of Keynesian theory.

The Austrian idea that economic coordination in market economies fundamentally requires universally flexible prices determined by the dynamics of supply and demand curves is wrong: economic coordination – to the extent that it does exist – can be created by “quantity signals,” as Nicholas Kaldor long ago understood.

(2) Many Austrians still adhere to an unrealistic market tendency to equilibrium states. But that is an unconvincing view of markets. Austrians do not take seriously their own ideas of (1) subjective expectations and (2) Knightian or fundamental uncertainty.

(3) There is no equilibrium (or market-clearing) interest rate that equates savings and investment. This is just another unsupportable equilibrium idea. If investment depends very much on business expectations, it does not matter how low interest rates are, if business expectations are shocked.

(4) Moreover, we live in an endogenous money world, and although credit does play a fundamental role in driving business cycles, the Austrians have never understood the real problem: credit flows to destabilising asset price speculators.

If Austrians really understood this, their business cycle theory would be concerned with the destabilising role of secondary financial and real asset markets, not with (largely imaginary or overrated) distortions in the capital goods structure of production.

If Say’s Law is defined in some minimal form like “consumption cannot occur without prior production,” then it is a trivially true proposition that is no threat whatsoever to Keynesianism or MMT.

(6) Why are money and secondary financial assets so important for any realistic model of capitalism? The reason is that money and secondary financial assets have a zero or very small elasticity of production. This means that a rise in demand for money or financial assets, and a rising “price” for money (i.e., an increase in its purchasing power) or financial assets will not lead to businesses “producing” money or financial assets by hiring unemployed workers.

Furthermore, the implicit assumption of both neoclassical theory and Austrian economics is the gross substitution axiom: that underlying the operation of all demand curves is the assumption that substitutes for all goods whose prices rise can be found or will emerge, and that even reproducible goods can substitute for non-producible assets and money.

But money and financial assets have zero or near zero elasticity of substitution with producible commodities:

“The elasticity of substitution between all (nonproducible) liquid assets and the producible goods and services of industry is zero. Any increase in demand for liquidity (that is, a demand for nonproducible liquid financial assets to be held as a store of value), and the resulting changes in relative prices between nonproducible liquid assets and the products of industry will not divert this increase in demand for nonproducible liquid assets into a demand for producible goods and/or services” (Davidson 2002: 44).

The gross substitution axiom is a fundamental assumption of neoclassical economics and the Austrians appear to tacitly assume the axiom as well. But the gross substitution axiom is wrong, and all inferences made from it in economic theories are also wrong.

Come to think of it, I could debate Murphy myself, or any Austrian for that matter. I could take most of them down in an hour or so!

34 comments:

Which Austrian economist would you have had in mind, LK? I immediately have Israel Kirzner in my thoughts for whatever reason.

Whether Murphy is right or wrong in his assertions, I still like how he's able to have conversations with people like Daniel Kuehn and let people like him have a voice in their frequent debates on his blog. He also seems to have a good sense of humor as you can see from his karaoke videos.

Well, Israel Kirzner is 83 (or so), isn't he? And probably too old to be interested in, or doing, debates.

Perhaps Joseph Salerno is a more "representative" Rothbardian?

In any case, despite what I say, you are right, Murphy is engaged, mostly civil, and I am sure he can defend the Austrian economics he does support reasonably well. I do read his blog regularly. I do so because it isan Austrian blog worth reading.

My point is: it is still odd for an Austrian to say he accepts a monetary theory of the interest rate and no Wicksellian natural rate.

Maybe will clarify his position on Rational Expectations. Is he also non-Austrian insofar as he believes in RE? Is this why he makes assertions about Ricardian Equivalence?

I doubt Murphy will do this as he strikes me as not having clarified his own position on many key issues in his own mind. From watching him speak in public I think that he just says whatever is opportune for him at the time to make ideological points. Murphy strikes me as being an anarcho-capitalist first and an economist second.

Again, I ask you whose fault it is that money has near zero elasticity of production.If there is a rising demand for money, than the the government should accommodate it through monetary or fiscal stimulus. The fact that it does not do so, the fact that it allows credit to collapse in the face of rising liquidity preferences, is a failure on the GOVERNMENT"S part, NOT, the private markets

(1) "I ask you whose fault it is that money has near zero elasticity of production."

I think you have misunderstood what money's zero or near zero elasticity of production even means.

It means private business does not *produce/manufacture* money by hiring unemployed workers:

"A zero elasticity of production means that there is no change in the number of workers in the money producing industry required to provide any given percentage change in the quantity of money supplied.

An endogenous (credit) money supply, on the other hand, usually implies an infinitely elastic quantity of money supply curve – the horizontalist argument of Moore (1988) – even though the credit money's elasticity of production is approximately zero. In essence, there will be little or no change in employment in the banking (credit supplying) industry to produce any change in the quantity of credit money supplied."

Davidson, P. 1996. "In Defence of Post Keynesian Economics: A Response to Mongiovi," in S. Pressman (ed.), Interactions in Political Economy: Malvern After Ten Years. Routledge, London and New York. 120-132 at p. 128.

Having the central bank simply inflate the base money will not employ unemployed workers.

(2) "If there is a rising demand for money, than the the government should accommodate it through monetary or fiscal stimulus."

Monetary "stimulus" isn't a reliable stimulus at all. As I said, if businesses expectations are shattered, and if they are already overloaded with private debt, expanding by the base money by 1.5 trillion or thereabouts will not induce them to create the necessary level of investment.

As I have told you again and again: witness the failure of QE1, QE2 and QE3.

If you are endorsing fiscal stimulus here, well, we can agree on that.

(3) "The fact that it does not do so, the fact that it allows credit to collapse in the face of rising liquidity preferences, is a failure on the GOVERNMENT"S part, NOT, the private markets"

What you are implying here -- bizarrely -- is that the private sector could manage perfectly well without even a central bank.

If the government central bank cannot induce the necessary level of private investment -- even with its vast powers of money creation -- what makes you think a private sector fractional reserve banking system can?

If anything, a wholly private monetary and banking system would be in a much worse situation than any central bank -- why, they could not even stop mass bank runs and bank collapses without a central bank.

Part 1"(1) "I ask you whose fault it is that money has near zero elasticity of production."

I think you have misunderstood what money's zero or near zero elasticity of production even means.

It means private business does not *produce/manufacture* money by hiring unemployed workers:"

Again, that's because only , U.S dollars, or British pounds, or Japanese Yen, are accepted to discharge obligations for US British and Japanese taxes, respectively. It's the doing and statutes of governments that have tenderized fiat money. Not that this is a bad or good thing. I am just clarifying the issue.

(2) "If there is a rising demand for money, than the the government should accommodate it through monetary or fiscal stimulus."

Monetary "stimulus" isn't a reliable stimulus at all. As I said, if businesses expectations are shattered, and if they are already overloaded with private debt, expanding by the base money by 1.5 trillion or thereabouts will not induce them to create the necessary level of investment."'

The monetary base by itself is not the issue. NGDP growth is the issue. .And your position is an absurd and ridiculous one. Do you believe that without QE1 by chariman Bernanke, NGDP, growth would have remained the same?. Of course not, it would have been lower. The whole purpose of monetary stimulus (and fiscal too) is to reignite income and inflation expectations. No matter how big the debt load, no matter how painful the previous demand depression, its always easy for the central bank to create new money in circulation. Your position requires a correlation of zero between the monetary base and NGDp growth, a ridiculous and absurd condition. Do you have any doubts that if the CB bought the ENTIRE bond market, municipal, private, and central government, that this would create inflation?If you don't then you acknowledge that MS works, and your position is nonsense upon stilts.

"As I have told you again and again: witness the failure of QE1, QE2 and QE3."

And as I have told YOU again and again,. QE1, QE2, and QE3, are squirt guns firing gentle water streams at firestorms. Come on! You should know this. You're a Keynesian. You should be hip to "the stimulus was too small" argument.

"If you are endorsing fiscal stimulus here, well, we can agree on that."Its nice too know we can agree on something. payroll tax cuts, are a very good idea by Mr. Mosler.

Again, that's because only , U.S dollars, or British pounds, or Japanese Yen, are accepted to discharge obligations for US British and Japanese taxes, respectively.

No, this is a non sequitur.

"Your position requires a correlation of zero between the monetary base and NGDp growth, a ridiculous and absurd condition."

It does not require that. I would say that the relationship between monetary base expansion and credit expansion (whether consumer credit or capital goods investment) is variable and an unreliable mechanism. While it is not zero, it is still woefully inadequate in unusual times as in 2008 onwards.

"Do you have any doubts that if the CB bought the ENTIRE bond market, municipal, private, and central government, that this would create inflation?"

What is needed is not inflation, but private investment.

Anyway, we just do not agree.

Your present position is what? The Fed needs to create $30, $40 or $50 trillion dollars of base money?

The problem with relying on management of inflation expectations is it assumes the expectations of elites are what drive the economy. It is an extraordinarily top-down view that those in the know will respond to open-market operations and drag the lower classes along with them in the direction desired by the central bank, as well as thoroughly undemocratic.

The reality is that the vast majority of Americans have never heard of the FOMC, do not spend time calculating future inflation and will not alter their behaviors to suit Ben Bernanke's goals.

In any case, igniting "inflation expectations" in the way you want is unlikely to induce the necessary level of investment.

It will most probably just cause instability on financial, asset and commodity markets, as commodity speculation soars as a hedge against inflation, and a flight to real assets like gold happens and so on.

It will just be end of Bretton Woods all over again: a lot of cost push inflation from inflation in factor inputs and energy and possibly stagflation.

""What you are implying here -- bizarrely -- is that the private sector could manage perfectly well without even a central bank.

If the government central bank cannot induce the necessary level of private investment -- even with its vast powers of money creation -- what makes you think a private sector fractional reserve banking system can?

If anything, a wholly private monetary and banking system would be in a much worse situation than any central bank -- why, they could not even stop mass bank runs and bank collapses without a central bank."

First I don't concede the point that a CB cannot reignite NGDp and the economy. Second, a private FSB banking system probably still has a commodity standard attached to i, as we saw in U.S. history. In that case, what matters is the conversion rate between banknotes and a certain unit og gold or silver. For example, too make things simple, lets assume a GS, and that an ounce of gold is worth twenty dollars. the economy is humming nicely, but the private debt load is rising. An asset bubble bursts. Panic ensues. bank runs start too happen. your very strange argument would have this be the fault of the private sector. But, in this case, all the Congress and Treasury has to do is to decree that an ounce of gold is no longer worth $20, its worth $30, or $40, essentially to devalue against gold. This will create new money and liquidity, and eventually stoop bank runs. If the government does not do this, if it sits on its bum does does nothing, if it listens to very stupid "Very Serious People" who gasp in horror at devaluation, why its THE GOVERNMENTS fault, yet again, and NOT the private sectors

If there is one own rate per commodity but only one of those commodities is commonly used as money then if the rate for that one commodity is below its equilibrium rate then the conditions for ABCT exists.

There may be other reasons for challenging ABCT but this is not one of them.

"Hayek's “natural rate” is an “equilibrium rate”: a rate that clears the various loan markets for real goods lent out as capital goods (whether durable or non-durable capital)."

is incorrect. The point is that in the theoretical barter economy there will as many own-rates as there are goods lent out. Do you disagree ?

If one of these goods becomes the only good that is lent out then it will be the interest rate for that good that will be the relevant one for ABCT.

Of course once you move to this commodity money model you need a theory to explain how money prices of capital and consumer goods will align around this money rate - and both Keynes and Hayek have provided such theories.

"Hayek's “natural rate” is an “equilibrium rate”: a rate that clears the various loan markets for real goods lent out as capital goods (whether durable or non-durable capital)."

is incorrect."

Then we are having a completely different discussion here. If you do not define the Wicksellian natural rate in the way Hayek did, then you are not trying to defend his specific theory.

(2)"The point is that in the theoretical barter economy there will as many own-rates as there are goods lent out. "

In theory, yes.

(3)"If one of these goods becomes the only good that is lent out then it will be the interest rate for that good that will be the relevant one for ABCT."

No, this is a non sequitur.

No matter what commodity you arbitrarily pick as a "natural rate", if it is not a market-clearing rate that clears the multiple and heterogeneous capital goods markets, then the Hayekian ABCT will not work.

"No matter what commodity you arbitrarily pick as a "natural rate", if it is not a market-clearing rate that clears the multiple and heterogeneous capital goods markets, then the Hayekian ABCT will not work."

Agreed: But the point is that Hayek and Keynes have theories to explain how the money interest rate will be a market-clearing rate and in Hayek's case how this rate will drive the same outcomes as in a barter economy where loans are made in multiple goods.

A simple way to look at this is to see what happens as we move from a barter economy with loans in multiple goods to a commodity money economy where all loans are made in one commodity and finally to a fiat money economy. It can be shown how the same outcomes (in equilibrium) will be driven in all 3 cases.

In addition: Your answer to (2) accepts multiple-rates, but your answer to (1) re-asserts a single rate again.

To spell it out: Even in a money economy there will still in theory be multiple own rates of interest. If I was to start-up a fruit bank in a money economy then the strawberry rate, the blackberry rate etc would all be different to the money rate even in equilibrium.

However as fruit banks and banks trading in other commodities don't exists the only rate that does matter is the money rate.

The "own rates" of other goods can still probably be calculated for goods (like corn) where spot and futures markets exists.

But Keynes gave up the idea of a market-clearing interest rate. He abandoned the natural rate idea between the "Treatise on Money" and his writing of the "General Theory."

And as I have said before, even his "marginal efficiency of capital" notion -- a replacement for the natural rate to some extent -- is dismissed as erroneous and unnecessary by a number of modern Post Keynesians (e.g., Robinson and Minsky), and I think rightly too.

the fundamental oversight is the difference between fixed and floating fx policy:http://moslereconomics.com/2010/10/04/exchange-rate-policy-and-full-employment/

For example, any fx trader knows that if you short $HK you drive up short term interest rates, as spot fx is fixed. But if you short the yen the spot goes down with the forward and the interest rate remains unchanged.

Unfortunately none of the academics seem recognize this and its ramifications for the rest of their 'theory'

note that the natural rate concept is applicable to a commodity based convertible currency, like the dollar on a gold standard. It's entirely inapplicable to a floating exchange rate policy/non convertible 'fiat' currency. For floating fx 0% is best considered the 'natural rate' as that's were the risk free rate goes in the absence of govt. support of a higher rate:

On a gold standard the idea is that the interest rate- the differential between spot and forward prices for gold- reflects that relationship for the one commodity, which in this case is gold. And so with market forces expressing relative value to gold via price, spot and forward prices of all commodities do just that. A material complication, however, is that risk of devaluation/default is being priced as well as any 'own rate' (forward vs spot preferences) forces.

Even more fundamentally, they would be the first to expound on the effects of imperfect competition, yet fail to recognize that taxation is the introduction of imperfect competition to any model. And with fiat currency, where the only thing acceptable for payment of taxes is the currency only the govt is allowed to issue, the model is no subject to that big fat whopping monopoly. And they all know a monopolist who constrains supply is the cause of excess capacity, unemployment, etc. etc.

Actually, in the way Hayek defined the "natural rate" (borrowed from Knut Wicksell), it was a single non-monetary rate that clears the various loan markets for capital goods (whether durable or non-durable capital). Defined in this sense, it is the basis of virtually all versions of the (obviously false) Austrian business cycle theory.

To be honest, I do not think the "natural rate" is even applicable to a commodity-based convertible currency system (such as the gold standard).

The curious point is that Murphy does not think the unique natural rate even exists, so you will not have to waste your time debating that with him!

I'm also reasonably convinced that the current version of qe functions mainly as a tax. Note that the 90 billion the fed turned over to the tsy for 2012 would have otherwise been earned by 'the economy'. In fact, with govt a net payer of interest, i see positive rates as a subsidy and negative rates as a tax. note the deposit tax in cypress is to me an example of negative rates, as was the 'bond tax' on Greek debt. which, of course, made the economy worse.

I think the data substantiates my suspicions, but it's ultimately a matter of the propensities to consume out of interest income,etc. which can't be 'proved' etc.

But in any case I don't think the Fed has any tools to alter NGDP, at least not in the direction they presume. In general, I attribute changes in NGDP to fiscal policy.

Yes, the current fad amongst monetarists: the "we-just-need-more-monetary-NGDP-targeting!" cry makes no sense.

If QE1, QE2, and QE3 did not induce the necessary level of private investment, it's foolish to think more QE will.

Also, I agree that interest payments on bonds do seem like an addition to aggregate demand, if they are spent, of course.

In fact, I suspect the vast stock of government bonds after WWII was actually a positive element causing financial stability in that era: with all those safe assets about, there was less blowing of bubbles in private sector assets (I think Minsky may have already said something like this).

Although the bond interest isn't earned by the economy directly, isn't it earned by the economy indirectly by government spending.

So if you have a government that thinks the limit on government spending is $300bn and they spend $90bn on interest then they will only inject $210bn into the economy. However if the interest disappears they'll inject $300bn - a $90bn increase.

Bear in mind that NGDP monetarists seem to be talking about buying things other that government bonds - securitised mortgages primarily I think.

That makes the central bank the biggest sub-prime sucker in the game AFAICT.

"(3) There is no equilibrium (or market-clearing) interest rate that equates savings and investment"

Let me comment on this. With fixed fx, rates (nominal=real with fixed fx) are market determined, so savings will always equal investment (as a matter of accounting) in any case, but regarding interest rates, the causation is that it's the savings/investment dynamics that determine interest rates.

With floating fx, however, it's the CB that sets the nominal rate, not the market. And investment remains largely a function of sales/sales prospects at prices where acceptable returns on investment can be realized, with interest rates part of the cost of production but also, with the govt. a net payer of interest, as source of net interest income for the economy.

When I say there is "no equilibrium (or market-clearing) interest rate that equates savings and investment", I am thinking of loanable funds theory here: even if loanable funds theory were true (which obviously it is not), the idea that some lower interest rate will cause investors/businesses to seek more loans and clear the market of bank savings is unrealistic, because of the instability of expectations.

Of course, with an endogenous money world, loanable funds theory is itself nonsense, so I suppose I am being very "theoretical" here in my criticisms of Austrians.

ok,Actually 'loanable funds' is the case with fixed fx policy, where the interest rate is market determined. So with fixed fx savings/investment dynamics are the 'market determined/cause' of the resulting interest rate. And if the CB intervenes to alter that interest rate it will either gain or lose it's reserves until somehow, if ever, market forces result in the interest rate the CB is attempting to target.

However with floating fx it doesn't work that way. Without the state supported option to convert at a fixed price, the CB necessarily has to set rates, or the 'risk free' rate remains at 0% permanently.

The problem is with fixed fx you have a 'textbook' case of fractional reserve lending, as banks must hold reserves of 'real convertible currency' in case depositors want to take their funds out of that bank. And the central bank is always limited by its reserves as to how much convertible currency it can advance, as convertible currency can be 'cashed in' for the gold or whatever the currency is fixed to. So a fixed fx regime is 'always and necessarily reserve constrained' in that sense.

After Bretton woods yes, the US set rates but with the consequence of dollar outflows if the rates were too low, which for the most part they were. And the evidence is that the ratio of 'convertible dollars' outstanding vs actual gold reserves reached about 4:1 by 1971 when France demanded gold and Nixon said no. So while the dollar was 'legally' convertible internationally for all practical purposes it wasn't, since the first nation to ask for its gold was turned down.